Why LIFO Is Banned Under IFRS (2024)

FAQs

Why LIFO Is Banned Under IFRS? ›

IFRS prohibits LIFO due to potential distortions it may have on a company's profitability and financial statements. For example, LIFO can understate a company's earnings for the purposes of keeping taxable income low. It can also result in inventory valuations that are outdated and obsolete.

IAS 2 prohibits LIFO; US GAAP allows its use.

Unlike US GAAP, IAS 2 prohibits LIFO as a cost formula. The International Accounting Standards Board (IASB® Board) eliminated the use of LIFO because of its lack of representational faithfulness of inventory flows.

Accounting Standards for FIFO and LIFO in the US

FIFO is permissible under both U.S. Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS). LIFO is allowed under GAAP in the U.S. but prohibited under IFRS followed outside the U.S.

In the U.S., companies must align with the Generally Accepted Accounting Principles (GAAP). These principles allow using FIFO (First-In, First-Out) and LIFO (Last-In, First-Out) methods. Unlike GAAP, the International Financial Reporting Standards (IFRS) do not recognize LIFO.

One of the most basic differences is that GAAP permits the use of all three of the most common methods for inventory accountability—weighted-average cost method; first in, first out (FIFO); and last in, first out (LIFO)—while the IFRS forbids the use of the LIFO method.

IFRS prohibits LIFO due to potential distortions it may have on a company's profitability and financial statements. For example, LIFO can understate a company's earnings for the purposes of keeping taxable income low.

Last in, first out (LIFO) is only used in the United States where any of the three inventory-costing methods can be used under generally accepted accounting principles (GAAP). The International Financial Reporting Standards (IFRS), which is used in most countries, forbids the use of the LIFO method.

This means that LIFO is only legal in the United States, as much of the remainder of the world primarily utilizes IFRS, which is focused on a first-in, first-out (FIFO) approach. Inventory cost goes a long way toward determining what kind of taxable income a company will report to the IRS.

A taxpayer must use the LIFO method for book purposes and for any income statements to shareholders in the year the taxpayer adopts the LIFO method and any subsequent year. Financial statement conformity requirements when using the LIFO inventory method are covered in Treas. Reg. 1.472-2(e).

Mixed use.

The United States is the only country that allows corporations to use LIFO. About 16% of companies in the S&P 500 used LIFO in 2021, according to a report from Credit Suisse, with about 53% using FIFO, and the remainder using a variety of other methods.

Why is LIFO controversial? ›

Criticism of LIFO

Opponents of LIFO say that it distorts inventory figures on the balance sheet in times of high inflation. They also point out that LIFO gives its users an unfair tax break because it can lower net income, and subsequently, lower the taxes a firm faces.

Last-In, First-Out (LIFO) inventory deductions allow companies to deduct the cost of inventory at the price of the most recently acquired items and assumes that the last inventory purchased is the first to be sold. LIFO limits the impacts of volatile prices or inflation and lowers the tax cost of new inventory.

LIFO in Accounting Standards

However, under GAAP, the use of Last-In First-Out is permitted. The inventory valuation method is prohibited under IFRS and ASPE due to potential distortions on a company's profitability and financial statements.

Disadvantages of Using LIFO

LIFO is more difficult to maintain than FIFO because it can result in older inventory never being shipped or sold. LIFO also results in more complex records and accounting practices because the unsold inventory costs do not leave the accounting system.

However, last-In, first-out does come with a few disadvantages. One of its drawbacks is that it does not correspond to the normal physical flow of most inventories. Also, the LIFO approach tends to understate the value of the closing stock and overstate COGS, which is not accepted by most taxation authorities.

Last In First Out (LIFO) method is not used in process costing, since the underlying assumption of process costing is that "the first unit prodoced is, in fact, the first unit used, which is the FIFO concept.

LIFO method and all subsequent years it uses the LIFO method. Once adopted, a taxpayer must use the LIFO method unless the IRS Commissioner consents to termination. A taxpayer must maintain adequate records to enable verification of its inventory computation and compliance with the regulations.

In the U.S., if the LIFO conformity rule were not changed, eliminating LIFO for financial reporting would trigger tax consequences for current LIFO users. Thus, current LIFO users strongly oppose its elimination.